Interests clash in city's finance sector

As Congress and the White House hash out details of how to fix the nation's financial system, the outcome could have huge but vastly different consequences for Boston's banks, mutual funds, insurers, hedge funds, and other financial companies.

"I don't think the impact of this can be overblown," said Richard C. Wilson, a Boston hedge fund consultant. "Everything is being reformed; everything is going to change."

Trade groups are lobbying Capitol Hill to ensure companies benefit from the various steps the government is taking - and to limit new regulation of their operations. Questions range from whether hedge funds should be included in the government's $700 billion purchase of troubled assets to how community banks can recover losses in the troubled mortgage lenders Freddie Mac and Fannie Mae.

Some issues pit Boston companies against one another. Banks are pushing to limit how much insurance the federal government will provide to cover losses in money market mutual funds, which last week experienced a run as losses at a few funds sparked billions of dollars of withdrawals industrywide.

Bankers said the government insurance gives money market mutual funds a competitive advantage over traditional savings and checking accounts, although limits the Treasury Department imposed Sunday address some of the bankers' concerns. Money market mutual funds are investments that can lose money and are not insured. Banks and brokerages offer savings, checking, and money market accounts that are insured up to $100,000 by the Federal Deposit Insurance Corp. but generally pay lower interest rates. Bankers said the new government insurance would give money market mutual funds a competitive advantage because those funds could offer higher interest rates and still offer the assurance of government backing.

On the other side, mutual fund firms such as Putnam Investments stand to benefit. Last week Putnam chose to close a $12.3 billion money market mutual fund after withdrawal requests put the firm at risk of selling holdings at a loss.

A major issue for the financial firms is dealing with competing proposals - from the administration, the Senate, and the House - describing which companies would be eligible for buybacks. Firms want to be able to unload losing investments, but would face differing degrees of regulation depending on which proposal prevails.

Lightly regulated hedge funds, for example, face big questions about whether to be included in the list of financial firms that can sell losing mortgage-related investments to the government. Although its exact size is unclear, the hedge fund sector in Boston is large and thriving.

Bert Ely, a veteran industry consultant in Washington, said the version of the bailout being developed by Senate Banking Committee chairman Christopher Dodd appears to define eligible companies so broadly that hedge funds would be included. He noted a line in the Connecticut Democrat's proposal indicating the government could buy the securities from any investor if it is "necessary to promote financial stability."

However, US Representative Barney Frank, Democrat of Newton and the House's chief strategist on the bailout, has repeatedly said hedge funds would have to accept greater regulation in exchange for government buyouts. That is unacceptable to an industry that isn't required to disclose its investing strategies or results because it does not make its funds available to the general public. David Friedland, president of the Hedge Fund Association, said his members would not be willing to make that tradeoff.

"Just regulation for the sake of having regulation that doesn't accomplish what it seeks to accomplish and places an undue burden on hedge funds . . . would obviously be opposed," he said.

The hedge fund sector is also fighting the Securities and Exchange Commission's emergency orders that temporarily ban short-selling in 799 financial stocks and require investors to report their short positions. Short-selling is when an investor borrows a stock and sells it, hoping its price will drop. If it does, the investor buys the stock back at a lower price, and pockets the difference as profit. The SEC said it was worried waves of short-selling were worsening the credit crisis.

Some hedge funds are discussing whether to sue the SEC, according to Richard Baker, president of another industry trade group, the Managed Funds Association. He said his organization has also discussed legal action but has no plans to sue. Baker said disclosure of short positions in particular would reveal how the funds try to make money.

"If you give anybody else in this business your trades over two to three weeks, they can pretty much figure out your proprietary trading strategies," Baker said.

Insurance companies, which were large buyers of the kinds of securities at the heart of the credit crisis, face similar tradeoffs. Frank, for example, wants institutions that sell such assets to the government to give the government an ownership stake in the company via either equity or preferred stock.

Currently regulated by each state they operate in, insurers don't welcome the prospect of federal regulation raised after the bailout of American International Group, said Robert Hartwig, president of the Insurance Information Institute. "Management likes to be in control," he said.

Banks, meanwhile, are fighting on another front. The government takeover of Fannie Mae and Freddie Mac wipes out dividend payments on the mortgage giants' preferred stock, which also made the value of those shares worth less.

More than a quarter of the country's banks hold these preferred shares, a survey by the American Bankers Association found yesterday, with the largest number of holders based in Massachusetts; banks like the preferred stock because of these dividend payments. Sovereign Bank recently said it would have to take an unspecified charge on its $623 million in holdings of both companies.

The American Bankers Association is pushing to have the federal government pay the dividends at least until the end of this quarter on Sept. 30, possibly longer. A Sovereign spokesman declined to comment.